What a liability? Exclusion clauses and liability for loss of profits Image

What a liability? Exclusion clauses and liability for loss of profits

Posted: 23/07/2014

Summary & Implications

A critical issue in many commercial contracts is the meaning, scope and enforceability of exclusion and limitation clauses. Businesses are often concerned that the courts will strain to avoid giving effect to exclusion and, to a lesser extent, limitation clauses and will try to find some way to render the clause ineffective or limit their intended effect.

However, in construing any clause in a contract, including an exclusion or limitation clause, the court should decide what the words would mean to a reasonable person having all the relevant background knowledge including the contract itself as a whole. If the words are clear and fairly susceptible of one meaning only, the court should give effect to that meaning, even if the result seems commercially improbable. The court should not distort the bargain which the parties have made; but rather uphold the allocation of risk agreed by the parties.  It is only if the words are ambiguous, that the court will give effect to the more commercially probable interpretation.

The judgment in Fujitsu Services Limited-v- IBM United Kingdom Limited does not make new law, but is a good example of the court giving effect to the natural meaning of the words in a not uncommon exclusion and limitation clause. It also illustrates that it may often be possible, and sensible, to have that issue determined as a preliminary issue in advance of the full trial, as the amount of recoverable damages will clearly have a significant impact on the conduct of the litigation. Accordingly, it can save considerable costs and lead to an early resolution of a dispute to have this issue determined as soon as possible.

Background Facts

In 2001, the DVLA contracted with PWC to transform its business processes and consolidate and improve its information, communications and technology systems. PwC and Fujitsu submitted a joint proposal to provide the services required and, shortly after it was accepted, IBM purchased the consultancy business of PwC.

IBM provided its services to the DVLA under a main contract ("the PACT Agreement"). IBM agreed to sub-contract to Fujitsu certain of those services under a sub-contract with IBM ("the Sub-Contract").

Fujitsu contended that it had no direct means by which to ascertain what services were being requested or provided under the PACT Agreement and was thus reliant on IBM to obtain work under the PACT Agreement, to notify it of such work and to sub-contract to it the share of work to which it was entitled.

Fujitsu alleged that, in breach of contract, IBM failed extensively to sub-contract to it services in accordance with the Sub-Contract and that it had suffered a loss of revenue of £36.8m as a result of having been wrongfully deprived of work under the Sub-Contract. Fujitsu claimed for the loss of profits it suffered as a result and/or an account of profits made by IBM retaining the work to itself.

IBM defended the claim on a number of bases but, in particular, relied on the exclusion and limitation clauses. The validity and meaning of those clauses was determined as a preliminary issue.

The relevant clauses

The relevant clauses provided that:

Limitation clause

'20.4 Subject to certain exceptions, PwC's liability to Fujitsu… shall be subject to the following limits:

c) subject to Clauses 20.4(d) and 20.8, in respect of any Claims or losses arising PwC's aggregate liability to Fujitsu arising under this Sub-Contract in each Contract Year shall be limited to £5 million for all events or failures giving rise to such Claims or losses;

d) notwithstanding the cap set out in Clause 20.4(c), PwC's overall aggregate liability for all Claims or losses arising under this Sub-Contract shall be limited, subject to Clause 20.8, to £10 million for all events or failures giving rise to such Claims or losses.'

Exclusion clause

'20.7 Neither Party shall be liable to the other under this Sub-Contract for loss of profits, revenue, business, goodwill, indirect or consequential loss or damage.'

There were certain exceptions to that, which are not relevant for the purpose of this article.

The Court’s Decision

In a pellucid decision, the Judge decided that the terms of the exclusion and limitation clauses were clear and rejected all Fujitsu’s arguments that they were not effective.

Accordingly, IBM's liability in respect of all of Fujitsu's claims was excluded by clause 20.7, as those were claims for loss of profits and/or loss of revenue and/or loss of business and did not fall within any of the specific exceptions provided for, save for any liability for the claims for an account of profits.

IBM's liability in respect of all of Fujitsu's claims, including any liability on the account claims, was limited to £5million in each Contract Year and/or to £10million in the aggregate because of clauses 20.4(c) and/or (d).

The Judge determined the meaning of the clauses according to their express language and concluded that any liability on the part of IBM for damages fell within the exclusion clause. The language of the exclusion clause was on its face clear and unambiguous and there was nothing in the context or surrounding clauses of the Sub-Contract that pointed to any different construction than a simple application of the words. The exclusion clause excluded liability not by reference to any particular cause of action or type of claim, but rather by reference to particular types of loss.

However, a claim by Fujitsu for an account of profits wrongfully made by IBM was not a claim for loss of profits suffered by Fujitsu. Such claims were not for loss on the part of Fujitsu but for an allegedly wrongful gain by IBM. They were claims for a different remedy than a claim for loss, and would result in a financial award, if any, for a different amount. Accordingly, such claims were not excluded by the exclusion clause. However, the limitation clause limited IBM’s liability for all claims, including claims for an account of profits. The wording of that clause covered any claim rather than type of loss.

Mere statement of intent

When loss of profits is excluded, it can seem as if the contract is, for all practical purposes, unenforceable, as there would be no sanction for non-performance by the defendant.

Indeed, Fujitsu argued that a central element of the parties' bargain was deprived of all contractual force or reduced to a mere statement of intent by reason of the exclusion clause.  The clause should therefore be construed so as to avoid such an absurd result, as it was inherently unlikely that the parties could have intended that the clause should have the effect of depriving one party's obligations of all contractual force.

The judge decided that the proper construction of a clause in a contract turns on its own words and relevant context and that the court should avoid reaching a conclusion on that basis, only if another construction was of the clause was available. But such an approach was of little assistance in circumstances where, as in this case:

1. The wording of the exclusion clause was clear. A considerable weakness in Fujitsu's case was its inability to identify any commercially sensible formulation of what the parties must otherwise have meant.

2. The exclusion clause applied equally to certain categories of loss suffered by both parties, rather than existing for the benefit of one party alone.

3. The exclusion clause was in detailed terms, contained in a lengthy and detailed contract, and tailor-made as a result of negotiation between two highly sophisticated commercial entities of equal bargaining power with the benefit of legal advice from experienced commercial solicitors.

In any event, the effect of the exclusion clause in this case was not to deprive the contract of all contractual force and render it a mere statement of intent. IBM was still obliged to pay sums due as charges for work done. A debt is not a loss of profits, revenue or business, and hence was not excluded by the exclusion clause.

Fujitsu also still had other remedies available to it- namely the dispute resolution mechanisms which allowed it to review the management of the work share arrangements. If those were unsuccessful, it still had the right to apply to the courts for declaratory relief and/or a claim for specific performance and/or injunctive relief. However, in AB-v-CD the Court of Appeal recently held that, if damages are an inadequate remedy because of an exclusion or limitation clause, an injunction is more likely to be granted to prevent the breach from occurring in the first place. Parties should therefore give careful consideration to applying for interim relief where damages are not an adequate remedy because of an exclusion or limitation clause.

Finally, the judge remarked that she was not persuaded that the exclusion of liability for loss of profits was in any way commercially unreasonable or inconsistent with business sense. She remarked that this was a case where a court should be very slow to intervene with its own view of commerciality. “Commercial parties are entitled to and do rely on commercial "mores"; they can choose to rely on trust and to prefer not to expose themselves or each other to litigation in due course - for sound commercial and professional reasons (para 87).”

Indirect or consequential loss

When considering the scope of an exclusion clause, thought has to be given as to whether liability for all loss of profits or just indirect profits is excluded. It is a common misconception that loss of profits is always a consequential or indirect loss. However, indirect losses are those which do not arise in the normal course of things from the breach but could reasonably have been contemplated by the parties at the time the contract was entered into as the probable result of the breach because they had knowledge of special circumstances outside the usual course of things.

In this case, Fujitsu argued that the reference to loss of profits was equivocal and that it excluded or limited liability for "loss of profits, revenue, business, goodwill" only in so far as the same constituted indirect or consequential loss or damage rather than direct loss. The judge rejected that argument. She said that the words were clear and there was no justification for construing the exclusion clause in a manner which limited it to indirect and consequential loss. One would expect it to be made clear if the intention was to exclude indirect loss of profit only. Loss of revenue, business or goodwill was not necessarily indicative of indirect loss.

Conclusions and reflections

Businesses are often nervous that the Court will not enforce the terms of exclusion or a limitation clause in an attempt to do ‘justice’.

However, as the Judge noted referring to another judgment, Tradigrain SA v Intertek Testing Services (ITS) Canada Ltd, the courts are “increasingly willing to recognise that parties to commercial contracts are entitled to apportion the risk of loss as they see fit” (Moore-Bick LJ, para 46, Tradigrain).

Construction of such clauses will always turn on the wording of the specific clause in question read in the context of the contract as a whole.  If, however, the words are clear and that there is no justification for an alternative meaning, the court should give effect to that meaning, where commercial parties are concerned.

The courts should respect such parties’ choice on the allocation of risk. If such parties chose to limit their right to claim damages from each other or even release each other from potentially very significant liabilities, the court should not interfere with that bargain.

Businesses should, therefore, make sure that their intentions are clearly expressed in the contract and think very carefully about rights they are prepared to give up or limit before entering into a contract.

This article was published in Procurement & Outsourcing Journal in July 2014.

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